Do you wish that you could build equity in your home more quickly? Would you love to pay off your mortgage sooner and own your home free and clear faster? This is a common dream shared by many homeowners, and some work toward it by paying more toward the loan’s principal. Is this a good plan? Would making additional principal payments be a smart move for you? Understanding how extra principal payments affect a mortgage will help you make an informed decision.
How Extra Principal Payments Affect a Mortgage
When weighing whether making extra principal payments is a good option for you, you need to know what the principal is and how it combines with other factors to form your total monthly mortgage payment.
As Investopedia explains, a monthly mortgage payment is normally the sum of four factors. The first is the principal, or the total amount borrowed. Some of each month’s payment will go towards paying this back. The second is interest, which is the fee that the lender charges for the privilege of borrowing money. Your real estate taxes are the third factor. One-twelfth of your annual tax bill is added onto your monthly mortgage payment; your lender holds these funds in an escrow account until it is time to pay the bill. The fourth part of the monthly bill goes to insurance payments for the property or for private mortgage insurance.
Why Paying Extra Principal Delivers Savings
As the Consumer Financial Protection Bureau notes, only a portion of the monthly mortgage payment goes to paying down the principal. A sizeable chunk of your payment goes to paying the interest, which continues to accrue each month for as long as you owe the lender. Paying extra towards the principal reduces the amount of principal. Reducing the amount that you owe reduces the amount of new interest that accrues. It can also help you pay off the loan faster. Plus, shortening the term of the loan means that there are fewer months when interest accrues. To put it simply, paying extra principal payments can result in substantial savings. This handy calculator makes it easy to see how extra principal payments affect a mortgage.
The Benefits of Paying Sooner Rather Than Later
Mortgage amortization, which is the process used to determine how much of your payment goes toward principal and how much goes toward interest, is a complicated subject. To put it simply, mortgage payments tend to be interest-heavy at the beginning of your loan (source). Since less of your scheduled payment is going to principal, extra principal payments have a larger impact, and deliver greater savings, when they’re made early in your mortgage. Adding even a little extra to your payments can have a significant impact on the amount of interest that you’ll ultimately pay, the total cost of your loan, and the length of time it will take you to pay it off.
Pros and Cons of Making Extra Principal Payments
Should you make extra principal payments? That depends on your financial situation and your goals. Devoting your extra cash toward paying down your principal can reduce the total cost of your loan and allow you to pay it off sooner, but those benefits have an opportunity cost (source). Money that is tied up in paying down your mortgage is money that you cannot use elsewhere to achieve other aims. If your interest rate is already low, it might make more sense for you to concentrate on paying down high-interest credit card debt, building a healthy emergency fund, or optimizing your retirement savings.
Tips for Making Extra Principal Payments
When you make extra principal payments, be sure to let your lender know they should be applied to the principal. You might find the following tips handy if you’re aiming to pay more toward your principal:
- Round up your mortgage payments each month. For example, instead of $743, pay $750 or even $800.
- Make an extra mortgage payment each year by dividing your required monthly payment by 12 and adding that amount to each month’s payment.
- Use tax refunds*, credit card rewards, bonuses, or other unexpected windfalls to pay down your principal.
Are you interested in learning more about how extra principal payments affect a mortgage? Would you like to explore similar topics like biweekly payments or refinancing? It would be our pleasure to assist you. At PrimeLending of Springfield, Missouri, we’re mortgage experts. We have the experience, expertise, and resources to provide you with the accurate information that you need to move forward confidently with your financial decisions. To arrange for an appointment with one of our friendly, knowledgeable financial professionals, contact us today.
*PrimeLending is not authorized to give tax advice. Please consult your tax adviser for tax advice for your specific situation.